The recent surge in attention being given to “activist shareholders” in Australia has seen them getting a more sympathetic ear from fund managers. Previously low profile funds are now showing a willingness to engage with activists to understand their proposals for improving share price performance rather than necessarily siding with the incumbents.
We recently hosted a series of panel sessions on shareholder activism where we heard from specialists on proxy solicitation, corporate governance, activist shareholders and large superannuation funds. The different perspectives of these participants were clear and highlighted the everyday tensions in the activist battle for corporate control.
THE SHAREHOLDER ACTIVIST BATTLEFIELD
Activist shareholders can have vastly different motivations and objectives. Some special purpose activist funds want to capitalise on short term opportunities. Other activists want to promote long term changes to the company’s strategic direction, like mergers or changes to capital management policies such as dividends, capital returns, buybacks or gearing levels. In the most disruptive cases, the activist may be an ultimate buyer of the company or its assets or may believe there is more value if the company is broken up with assets being sold or spun off.
The management team of the target company also face unique challenges. Activists typically begin their engagement by buying up a block of shares. They then sound out management often presenting an alternative view about how they think management can make changes to increase shareholder value. For the management team this can be a challenging start to a relationship and requires patience and a certain disinterested stance on the current strategy.
The stance of institutional shareholders to activists varies. Some are willing to align themselves with activists, opting to campaign to improve company performance and increase shareholder returns. Others prefer to back the incumbent management team, and while it is hard to generalise, the default position will usually favour preserving the status quo.
Corporates are not the only ones under pressure; active funds are also under pressure to demonstrate the benefit of their management style. Neither can afford to ignore the activist holders. In all cases our experience is that institutional holders will carefully review the position to make sure they are fulfilling their fiduciary duties.
Activist hedge funds have been incredibly successful. The Wall Street Journal reported that in 2013 US hedge fund activists won more than 68% of their proxy fights, compared to 43% the previous year. Returns for activist funds have outperformed the general market, leading to increased capital being allocated into this asset class and a need for activist funds to find more potential target companies. In the US, superannuation funds, university endowments and private institutions have all thrown their support behind activist campaigns. In many cases it seems that the view from these institutions is that hedge fund activists can step in to improve a company’s performance rather than just speculate on it.
The pressure to find opportunities has meant that US and UK activists are now targeting Australia. In addition there are a growing number of Australian-based activist funds.
THE ACTIVIST’S ARMOURY
The activist’s armoury consists of lobbying, putting forward shareholder resolutions – like board spill proposals and constitutional changes -- at general meetings, media campaigns and even litigation. Add to this the inevitable media pressure and public interest. The media loves the drama of a battle especially since it often boils down to an attempt to oust the board and this necessarily puts personal pressure on directors. That pressure is part of the stock in trade for activists but for many directors it is a kind of pressure with which they are not very familiar.
While Australian courts are more reluctant than their US cousins to explore the motivations of directors and so generally keep the outsider outside the boardroom, there’s no doubt that in general, the rules in Australia favour the activist. Not only is a 5% shareholding enough to requisition a general meeting to propose a board spill, but the 100-member rule (which the Federal Government intends to change) and the two-strikes rule are both potential grenades that can destabilise management in the hands of a skilled protagonist.
Potentially the most difficult legal rule is the rule left to us in 1987 by Justice Kirby and the NSW Supreme Court as a result of Larry Adler’s tilt at Advance Bank.
The Advance Bank Case set down strict criteria in relation to the directors’ conduct in a contested election including limits on the ability of directors to spend the company’s money to defend their positions. While the case has traditionally been narrowly interpreted and the boundaries about what is permitted remain murky, it does not mean that all electioneering is forbidden; just that the boundaries about what is and is not permitted are unclear.
Board spills and takeover bids both involve potential changes in control of a company. However, there are fewer protections for target companies in an activist campaign than a takeover bid. Unlike bidders, activists don’t need significant funding or detailed due diligence. With no bidder’s statement or similar disclosure obligations, activists also have minimal disclosure obligations.
Stephen Davidoff of the New York Times somewhat excitedly predicted that “the hostile takeover is on life support, if it’s not dead altogether. The hostile raider, however, has been replaced by the activist shareholder.” While they may be on the rise, it may be a little early to be writing obituaries for the hostile takeover, at least in this market.
SOMETIMES IT’S A MATTER OF PERSPECTIVE
If an activist takes control of the board then the other shareholders are not sharing in the premium for control. This has been seen as a ground of defence by some boards for “locking out” activists. While it is true that the activist model does not usually include paying a premium for control it is also true that all shareholders (without cost) should share equally in any improvement in a company’s performance (a so called “free ride”).
It is easy and simplistic to characterise the activist campaign as a game with some in white hats and some in black hats. The truth is that there are goodies and badies on both sides and like any battle for corporate control your view of the protagonists is heavily coloured by your perspective.
WHO IS MOST VULNERABLE?
Companies with the following characteristics are particularly vulnerable to shareholder activists:
- Weak share price: a strong share price is the best defence to shareholder activism. Most at risk are underperforming companies with problems that are ‘fixable’ and those with larger cash balances.
- Break-ups: companies that have multiple assets or divisions and are trading below sum-of-the part valuations are prime targets.
- Poor corporate governance and market communications strategy: companies with poor corporate governance and where management do not have a credible, well understood long-term strategy.
Companies can reduce their risk of being targeted by staying in regular contact with their shareholders, knowing what the shareholders are thinking and monitoring what they are doing at other companies.
WHAT IF I’M APPROACHED?
If an activist makes an approach, companies should be prepared to at least listen. There is no obligation to discuss or negotiate with the activist, but it pays to understand as much as possible.
If a company receives a requisition notice you should:
- assemble a team to assist the Board decide on its response
- confirm the validity of the requisition notice and what steps might be taken to strike it out
- ascertain who are the activist supporters, motives, past strategies and shareholder allies
During a proxy campaign you should monitor trading and understand what is being said in mainstream media, social media and the wider broking community. An experienced proxy advisory firm should be engaged and a careful strategy of communication with institutional and retail shareholders is essential. But remember it’s hard to make friends in a crisis! If you leave it until there’s a problem it will usually be too late.
Be prepared and patient. Activists are sometimes focussed on the short term, but in our experience many are willing to wait, sometimes years before taking action.
Activist shareholders are and always have been part of Australia’s corporate landscape. The number of successful funds in Australia and overseas means they are likely to be more active in the next few years. And more local institutions are going to engage with activists to explore opportunities to improve a company’s performance.
There are some simple steps you can take to limit an activist fund’s ability to use their leverage against you:
- First and foremost, you must have a clear and well understood strategy that is communicated to ensure that key shareholders understand management’s motivation and support their decisions.
- Secondly, you should be prepared to engage with activists to understand their motivation and to explain why the current strategy is preferable. This means looking at yourself from an activist perspective and making sure that your strategy is justifiably targeted at improving company performance.
- Lastly, when all else fails there will be a need for experienced counsel to help navigate the uncertain landscape of requisitions, proxy rules and director’s duties.